by David Hodges
In his 13 years as an insurance broker Bryan Yetman has regularly witnessed the havoc credit scores wreak on consumers. No case, however, unsettled the past president of the Insurance Brokers Association of Ontario (IBAO) more than that of a woman diagnosed with breast cancer while in the midst of a divorce a few years ago. The client needed a double mastectomy, which required time off work. She missed some bill payments due to the upheaval and her credit score plummeted. Her home insurance provider responded by doubling her premiums.
Yetman thinks this is outrageous. “Because you were late on a bill payment or you lost your job, is your house more likely to burn down?”
Inflated insurance premiums are just the tip of the iceberg when it comes to the ever-expanding use of credit scores for reasons for which they were never designed. “We have a situation where the credit score is now being needed for everything,” says Toronto paralegal Dan Barnabic, who represents clients in credit disputes. In the past, your credit score was intended solely to determine whether you could qualify for loans or credit cards, and at what interest rates and what limits. But now they’re checked when you get a cellphone plan, rent an apartment or even apply for a job.
No one can check your credit score without your permission, but many consumers are unaware they’ve given consent, because it’s usually buried in lengthy contracts filled with legalese. Equally troublesome, few people understand how certain activities (such as applying for a store credit card or closing an account) can affect their score, or that the credit reports on which these scores are based may be riddled with errors. Here’s what you need to know.
A powerful little number
When American analytics company FICO introduced the first widely used credit scoring system in 1989, it was intended to help financial institutions make complex, high-volume decisions about creditworthiness. Until then, banks had to review a borrower’s detailed credit report line by line to determine their risk. FICO simplified the process by using a mathematical formula to distill that information into a three-digit number that indicated how likely you were to pay a loan on time. In Canada, two competing firms—Transunion and Equifax—dominate the business, collecting payment information from lenders and other companies, aggregating, analyzing and selling it back to them in the form of credit reports and that all-important score.
Credit scores range from 300 to 900, with 600 considered the minimum required by financial institutions to gain access to a loan or line of credit. To receive the best possible interest rates, consumers typically require a score of 700 or more. Indeed, 50 or so points on your credit score could make the difference between a higher mortgage rate and a lower one that would save tens of thousands over the life of a loan. While your credit score isn’t the only thing lenders evaluate (income is a big factor), it’s hugely important.
Expanding its reach
Once credit bureaus began compiling detailed reports about consumers’ habits, it wasn’t long before banks hit upon the idea of using credit scores to evaluate the risk of the people who handle cash. “Maybe they’ll be tempted to embezzle if they have money problems,” or so went the logic, says Mike Morley, a mortgage and credit risk specialist in Toronto.
When the news spread to insurance companies—another industry that assesses the risk of millions of clients—a similar rationale was applied. Soon insurers were using credit scores to determine the likelihood a policyholder would file a claim.
Today credit scores are being exploited for other purposes—some justified, others questionable. Bryan Yetman says the credit score has become a “lazy broad-brush tool.” As a result, some consumers are being discriminated against or even denied services, based on information that may be irrelevant or inaccurate.
Checking your credit score when you sign a cellphone contract seems legitimate, as ability to pay bills is a major factor in the way it’s calculated (see “How your credit score works”). Likewise, landlords have good reason to gauge a tenant’s creditworthiness.
But while it’s reasonable for a bank to do a background check on money handlers, the practices of other employers are more dubious. Credit scores are being used by companies as a barometer for a job applicant’s general level of responsibility. That means if you’ve been sloppy about paying a utility bill or keeping up with monthly credit card minimums, it could impact your employability.
Take Torontonian Carlo Cazzin, who recently applied for a senior project manager position at a condominium. “You’re in if your credit score comes back healthy,” Cazzin recalls being told during his interview. After getting the job, he learned two other candidates had been passed over due to their poor credit scores.
The only area where the controversial use of credit scores has received any serious backlash is for the underwriting of insurance premiums. Critics of the practice, like Yetman, argue there’s no causal link between credit scores and increased insurance risk. Moreover, consumer advocates say credit-based insurance pricing leads to discriminatory practices because it unduly penalizes policyholders who either refuse to provide their scores, or whose credit was negatively affected by extraordinary events like the death of a spouse, serious illness, identity theft or loss of employment.
In a recent Canadian Council of Insurances Regulators (CCIR) report, brokers said they have seen rates increase by as much as 80% based on credit scores, and have even seen coverage denied. Some provinces have started siding with the brokers’ position. In 2011, Newfoundland and Labrador became the first provinces to prohibit use of credit scores for both automobile and personal property insurance. Smaller concessions in Alberta and Ontario disallow the use of credit scores for mandatory automobile insurance coverage, but there are no restrictions regarding personal property.
Understanding your rights
In most provinces, any person or company has the legal right to ask you for access to your credit score. In turn, you have the right to say yes or no. But declining a credit check is often not feasible unless you’re willing to go without a cellphone or insurance. And how many people can turn down a job that hinges on a credit check?
It’s rare to be in a position where you can deny someone access to your credit score, says Mike Morley. You could threaten to take your insurance business elsewhere, but chances are the competitor would ask the same thing. A survey by the Financial Services Commission of Ontario in 2009 showed 19 property insurers in the province (representing a 55% market share) were using credit scores and a further 6% planned to do the same in 2012. Today, says Brian Yetman, only a handful of Ontario property insurers aren’t using credit scores in their underwriting.
The Personal Information Protection and Electronic Documents Act of Canada (PIPEDA) states clearly that anyone requesting a credit score must receive your written consent in advance and it can be used only for the stated purpose. But many consumers are unaware what they’ve agreed to.
For instance, a poll conducted in December 2010 for the Insurance Brokers Association of Ontario on the use of credit scores by property insurers found 75% of consumers didn’t even know the practice existed. Banks and other financial institutions get away with it, says Morley, because they ask consumers to agree to lengthy privacy policies filled with fine print no one actually reads. Tedious as it may be, it pays to read the contract before you sign. “If someone wants you to sign something with small writing, take it home and read it, or don’t sign at all,” says Morley.
Other times, consumers may be misled by someone who is simply ignorant of the law. Debbie Gillis, manager of K3C Credit Counseling in Oshawa, Ont., points to her own experience at a Canadian Tire store, when an employee asked her if she’d like to sign up for the store’s credit cards in exchange for a free gift. Gillis declined, stating she didn’t want her credit checked. The employee vehemently insisted that wouldn’t happen, but had she signed the application it certainly would have.
Know the score
If you’re interested in protecting yourself you need to understand how credit checks can affect your score.
Whenever your credit is reviewed by someone other than a prospective lender it’s known as a “soft check.” These include inquiries you make yourself (see “Your credit score isn’t free,” p. 52), credit checks by businesses to offer you goods or services (such as an insurance company), or inquiries made by businesses with whom you already have a credit account (a bank periodically checking the status of your credit). Soft checks do not lower your credit score.
But whenever a lender reviews your credit because you’ve applied for a loan, mortgage or credit card, this is known as a “hard check.” Hard checks may result in a seven-point drop in your credit score. They can have an even greater impact if you have few accounts or a short credit history.
There’s an important exception. Credit bureaus know people shop around for mortgages and auto loans, so they generally consider multiple hard checks performed within two to three weeks as a single inquiry. “If you’re shopping for rates to buy a house or a car, be sure to do it quickly: not over the course of three months,” says Gillis. The Financial Consumer Agency of Canada advises consumers shopping around for a car or a mortgage should try to do it within a two-week period.
Each credit-card application, however, always counts as a separate inquiry. This is why consumers should be wary of signing up for retail and department store credit cards, says Dan Barnabic. Credit cards from stores like The Brick and Home Depot entice consumers because they offer deferred interest payments that appeal to young families.
But, says Barnabic, signing up for those two credit cards could lower your credit score by 14 points. If that same young family is also applying for a mortgage, the change in score could mean the difference between qualifying for the best lending rate or a higher “B-lender” rate, he cautions. (See “The real cost of a lower credit score,” p. 53, to learn what the consequences might be over the course of a five-year mortgage.)
Credit scores aren’t perfect
You may be surprised to learn credit reports often contain mistakes that translate into lower scores. A national survey by the Public Interest Advocacy Centre found a 20% error rate in which people sampled said items on reports were inaccurate or should have been removed. Based on his experience as a credit risk specialist, Mike Morley says the error rate may be as high as 40%.
Sometimes these errors are the fault of the credit bureau. Julie Harnum, a financial consultant in Toronto, was turned down for a credit card because Transunion accidentally combined the information in her credit report with that of her roommate, who had a poor credit history. “Luckily I was only applying for a VISA card,” says Harnum. “Had I been applying for a mortgage or a job at a bank, this could have had a great impact.”
Other times the credit bureaus may simply be given inaccurate information. Edward Peterson, a retiree in Ottawa (whose name we’ve changed at his request), was denied a cellphone contract because Equifax said his score was too low. But Peterson had always used his credit cards responsibly and paid his bills on time. Eventually, he discovered his credit score factored in outstanding support payments that had been paid in full. Correcting the information took months because the issue had to be resolved with the provincial government’s Family Responsibility Office (FRO) before the credit bureau would update his file. Peterson found the ordeal “incredibly frustrating.”
The point isn’t that mistakes happen: they’re inevitable. More troubling is that the onus to correct the error was on Peterson, not Equifax. Even though he had not been responsible for the inaccurate information in his credit report—a report the for-profit credit bureau sells to clients—he had to provide the FRO with a letter from his ex-wife’s lawyer stating he had never missed any support payments.
Dan Barnabic, who has handled hundreds of similar cases, says it takes six months to a year for credit disputes to be resolved due to Canada’s archaic consumer protection laws. “We’re ages behind the United States,” where credit bureaus must by law investigate complaints within 30 days.
It’s impossible to control all the information that goes into Canadians’ credit scores. But by regularly checking your report you‘ll know where you stand with the folks checking your score.
Your credit score isn’t free
Anyone can order a free credit report from Equifax or Transunion by mail, fax, telephone or in person, but this does not include your credit score. If you want to receive your credit report and credit score right away online, you can pay a $24 fee to the credit report agencies. Be wary of other organizations that offer free credit scores. To get the “free” score, you may have to sign up for a paid service. Fraudsters may offer free credit scores in an attempt to get you to share your personal and financial information.
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